Gary Stockdale of Vertem Asset Management shares his thoughts on asset allocation following the recent base rate rise.
'The major point of discussion since the team at Vertem last adjusted our asset allocation at the start of the current quarter has been the Bank of England’s Monetary Policy Committee (MPC) and its decision to raise base rates by 0.25%. As always it is the guidance, rather than the event, that matters.
For this we turn to the latest Inflation Report, by the Bank of England, which was issued in conjunction with the rate decision. The MPC noted that over the past few months the market has priced in a higher path for interest rates. The Committee has based its projections on a path that is premised on a gradual rise in the base rate to 1% by Q4 2020, which is 0.25% higher than that assumed in the August 2017 Inflation Report.
The tone was more dovish than the market was expecting, as evidenced by the decline in sterling and the shares of Lloyds Banking Group, post release. Lloyds is the largest UK focused current account and mortgage provider and is thus sensitive to rate expectations, as higher rates provide the potential to widen their net interest margin.
While mindful of reduced spare capacity in the UK economy, the MPC maintain that the main driver of CPI inflation rising to 3% has been companies passing on costs associated with the lower level of sterling. Indeed, the Inflation Report noted that sterling has declined by 18% since late 2015. In the absence of a further downward lurch, the impact of this gyration will work itself out of the system.
While we would not completely dismiss this notion, we are paying particular attention to how companies are managing rising costs through the course of our UK equity research. We are identifying more examples of higher costs that are still in the system. This has been played out in a battle of margins. Large companies have been pushing it back down the supply chain and costs have been cut aggressively.
Other tactics include shrinkflation and input substitution. On the latter, a raid on my daughter’s confectionary war chest led me to conclude that popular branded chocolate tastes of sugar rather than coco. But these actions are unsustainable and have run their course. You cannot constantly pressure your suppliers, cut costs and degrade your products. This pressure, must eventually yield to higher prices.
Furthermore, the uncertainty surrounding the Brexit process has prompted EU migrant labour to seek more stable climes. Labour shortages may well become more pronounced. It is going to become more difficult for employers to hold down wages. They are also likely to face calls for greater social justice, as workers become less tolerant of real wage declines.
This prompts us to be alert to the possibility of complacency in the consensus view that inflation pressures are almost exclusively transitory. We are therefore analysing our fixed interest positions to protect investors’ capital.
Elsewhere in the portfolios, we continue to be overweight equities. At the geographical level, portfolios are overweight Europe, Japan, Asia and emerging markets. As articulated in our October 2017 article, economic momentum in Europe has continued to build, the snap election in Japan has further strengthened prime minister Shinzo Abe’s position and economic data in the emerging markets have been broadly positive.
On the matter of Brexit, we expect ‘sufficient progress’ to have been made in time for the key December summit, which will clear the path for negotiations on UK’s future relations with the EU, as the former appears to be willing to concede further ground on the financial settlement.'
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